Credit Default Swaps Liquidity Modeling: A Survey

36 Pages Posted: 5 Mar 2010 Last revised: 12 Sep 2011

See all articles by Damiano Brigo

Damiano Brigo

Imperial College London - Department of Mathematics

Mirela Predescu

BNP Paribas, London

Agostino Capponi

Columbia University

Date Written: March 3, 2010


We review different theoretical and empirical approaches for measuring the impact of liquidity on CDS prices. We start by reduced form models incorporating liquidity as an additional discount rate. We review Chen, Fabozzi and Sverdlove (2008) and Buhler and Trapp (2006, 2008), adopting different assumptions on how liquidity rates enter the CDS premium rate formula, about the dynamics of liquidity rate processes and about the credit-liquidity correlation. Buhler and Trapp (2008) provides the most general and realistic framework, incorporating correlation between liquidity and credit, liquidity spillover effects between bonds and CDS contracts and asymmetric liquidity effects on the Bid and Ask CDS premium rates.

We then discuss the Bongaerts, De Jong and Driessen (2009) study which derives an equilibrium asset pricing model incorporating liquidity effects. Findings include that both expected illiquidity and liquidity risk have a statistically significant impact on expected CDS returns, but only compensation for expected illiquidity is economically significant with higher expected liquidity being associated with higher expected returns for the protection sellers. This finding is contrary to Chen, Fabozzi and Sverdlove (2008) that found protection buyers to earn the liquidity premium instead.

We finalize our review with a discussion of Predescu et al (2009), which analyzes also data in-crisis. This is a statistical model that associates an ordinal liquidity score with each CDS reference entity and allows one to compare liquidity of over 2400 reference entities. This study points out that credit and illiquidity are correlated, with a smile pattern.

All these studies highlight that CDS premium rates are not pure measures of credit risk. CDS liquidity varies cross-sectionally and over time. CDS expected liquidity and liquidity risk premia are priced in CDS expected returns and spreads. Further research is needed to measure liquidity premium at CDS contract level and to disentangle liquidity from credit effectively.

Keywords: Credit Default Swaps, Liquidity spread, Liquidity Premium, Credit Liquidity correlation, Liquidity pricing, Intensity models, Reduced Form Models, Capital Asset Pricing Model, Credit Crisis, Liquidity Crisis

JEL Classification: C51, G12, G13

Suggested Citation

Brigo, Damiano and Predescu, Mirela and Capponi, Agostino, Credit Default Swaps Liquidity Modeling: A Survey (March 3, 2010). Available at SSRN: or

Damiano Brigo

Imperial College London - Department of Mathematics ( email )

South Kensington Campus
London SW7 2AZ, SW7 2AZ
United Kingdom


Mirela Predescu

BNP Paribas, London ( email )

10 Harewood Avenue
London, NW1 6AA
United Kingdom

Agostino Capponi (Contact Author)

Columbia University ( email )

S. W. Mudd Building
New York, NY 10027
United States

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